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Saturday, November 23, 2013

BAIL IN

Did An Obscure IMF Document Start A Global Bail-In Revolution?

by Daniel R. Amerman, CFA
When revolutions start, it's not uncommon for almost nobody to
notice. It may take years or even decades before historians can look
back, point a finger and say "that's where it really began."
An obscure International Monetary Fund "Staff Discussion Note"
may have already started a "Bail-In" financial revolution that could
transform the global investment world.
In this quite remarkable document, the staff discusses a world
where risks to the global financial system have not gone away – but are
worse than ever. As candidly discussed, the "SIFI" (systemically
important financial institution) problem has not been improving, but
instead has been getting worse than ever – and there doesn't appear to
be any solution under existing contract law and bankruptcy law.
More risk than ever is concentrated in fewer financial
institutions, while there is no way under existing law to unwind a
failure of one of these institutions without risking triggering global
financial chaos. Moreover, there is a deadly feedback loop between these
"too-big-to-fail" institutions and sovereign governments. That is, as
the IMF staff discusses, the bailing out of these massive institutions
can bankrupt sovereign governments, and sovereign governments going
bankrupt can wipe out the "too-big-to-fail" institutions.
So the IMF staff has come up with an audacious plan for how the
globe can emerge from this seemingly impossible situation. The key word
is "insurance".
The proposal is to take selected classes of investments, and
retroactively decide that these assets aren't really assets at all.
Indeed, the owners of these assets have – without realizing they've
done it – agreed to provide insurance for the global financial
system. So if a major crisis arises, the global financial system merely
goes to these unknowing "insurance" providers and helps itself to
their assets effectively, and the crisis is dealt with. It's a miracle
solution!
Now there is the issue that some investors might actually object
to this taking of their investment assets for the greater good of
society. Which is exactly why the IMF staff recommends that this be
done by way of statutory law, in a manner that overrides contract law –
and is involuntary, with no investor permission needed. It would also
be retroactive as needed, thus applying to people who already own these
classes of investments.
After the bail-ins of the Cypriot banks and the Polish
retirement system, the development of bail-in procedures is spreading
rapidly around the world, including the EU, Canada and the United
States. What is fascinating and troubling - though perhaps not
surprising - is how global politicians are in practice completely
changing the "bail-in" concept, setting aside the IMF-proposed changes
that could have forced genuine banking reforms and potentially
increased global financial stability, and instead are creating a
broader threat to investors.
Moody's Investors Service has already lowered the credit ratings
of Morgan Stanley, Goldman Sachs, JP Morgan Chase and Bank of New York
Mellon in anticipation of possible future bail-ins. Moody's
accompanying statement explained: "Rather than relying on public
funds to bail out one of these institutions, we expect that bank
holding company creditors will be bailed-in and thereby shoulder much of
the burden to help recapitalize a failing bank."

A World At Risk

The IMF Staff Discussion Note is titled, "From Bail-Out To Bail-In: Mandatory Debt Restructuring Of Systemic Financial Institutions". Originally
released in 2012, it could be viewed as a source document for the
global movement to bail-ins.